The Overnight Report: When Bears Attack

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By Greg Peel

The Dow fell 344 points or 3% while the S&P lost 3% and the Nasdaq 3.2%. It was all downhill and markets closed pretty much on their lows.

Let’s start today in Europe, for it is Europe in particular, along with little cousin the UK, which are the primary focus of the latest phase of this bear market. The European markets close a few hours before New York, and last night the German index was down 2.9%, the French 3.2% and the British 2.5%.

New York is suddenly concerned about slowing global growth and nowhere is this more evident than in the other major economic zone. Last night both the ECB and BoE elected to keep rates on hold as they once again agonise over slowing economic growth in the face of inflation. Indeed, the specific brief of the ECB, unlike other central banks, is only to control inflation and not to focus on the EU’s economic growth, which is net of a disparate collection of power houses and basket cases. The ECB did, however, lower its economic growth forecasts.

The ECB’s last rate move was actually a hike, prompting howls of protest from the big export economies of Germany and France. Last night a data release showed German factory orders fell 1.7% from June to July and underlined the German’s dissatisfaction with the Frankfurt-based central bank’s monetary policy. But adding to weakness last night was an announced move from the ECB to tighten up its emergency lending facility which has been in place for much of the credit crunch, and which has been even more accommodative than that of the Fed’s.

It has been noted for some time in Europe, and more recently in the UK, that the central banks’ “emergency” facilities for swapping collateral in the form of toxic mortgage securities into government securities is being abused. The facilities are intended to overcome the credit market freeze which has followed the death of mortgage securitisation, but banks in Europe and the UK have been creating brand new mortgage securities and immediately swapping those for government paper at the well-intended emergency window. The banks are using the taxpayer to fund their ongoing businesses, not just their survival.

This practice has not been lost on the ECB, and so last night ECB president Jean-Claude Trichet announced a tightening of the rules. From now on collateral swapped will be subject to a “haircut” ranging from 5% for unsecured bank bonds to 12% for asset-backed securities. This means, in the latter case for example, $100 of asset-backed securities can be swapped for only $88 worth of government paper, not the $100 previously received. The result was, to take a selection, Credit Suisse shares down 5%, Deutsche Bank 6%, HBOS 7% and UBS 8.5%.

Wall Street woke to find Europe already tanking. But the news on the home front was no less inspiring. Firstly, the weekly jobless claim numbers showed a much larger than expected jump of 15,000, killing off four weeks of actual reductions. The monthly average is now running at 444,000, well above the “recession threshold” implied level of 400,000. This was not well received ahead of the monthly jobs data due tonight.

But more bad news was to come from the retail sector. It’s Back To School week in the US and already the signs are grim that the usual jump in retail spending is not happening. The only retailers to hold up are the discount stores, while the higher-end department stores are posting very poor performances. Shoppers are trading down and buying only the necessities. The Consumer Discretionary sector was trashed last night while Consumer Staple continues to hold up as the oil price falls.

The funny thing about the oil price, which fell another US$1.46 to US$107.89/bbl last night, is that its recent weakness was previously the driver of Wall Street rallies. But the further oil falls, the more Wall Street is focused on the root cause – diminished demand from a slowing global economy. Oil’s fall is now translating into stock price falls beyond just the energy sector.

Unsurprisingly it is the US multinationals – not long ago believed the saviour – that are leading the downward charge. The poster boy last night was US telco networking equipment maker Ciena, the shares of which dropped 25% after the company announced a drop in sales and lowered guidance as the big telcos start shying away from spending any money.

The financial sector had also been proving pretty resilient of late, but that dam broke last night as well. On top of the European influence, reports suggesting Lehman Bros and Merrill Lynch were having trouble cleaning up their balance sheets sent those stocks tumbling, while Lehman analysts downgraded Amex and sent its shares lower to boot.

Throughout the rout the US dollar almost apologetically rallied against European currencies, sending gold down another US$4.30 to US$795.60/oz. The dollar fell heavily against the yen however, which is often the case in big stock market down-days. This means hedge funds are unwinding their carry trade positions. It also means a double blow for the Aussie, which fell one and a quarter cents to US$0.8228.

There was also more weakness for the base metals in London, although with copper, lead and nickel all down one 1.5% it could have been worse. Zinc actually rallied 1.5%

Nevertheless BHP ((BHP)) and Rio ((RIO)) took further 3% hits in overseas trade. The SPI Overnight was down 153 points, or 3%.

Look out July lows. Rumours that the Fat Lady had been seen approaching the stage door have proved fallacious once more.

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